Debt-Free Forever

by Gail Vaz-Oxlade

  GAIL’S TIPS

  Perhaps the most successful ploy brought to you by lenders is the Minimum Payment Ploy. If you figure that a $2,500 trip is only going to cost you $64 a month, how can that be beat? Who can’t afford $64 for a much-needed vacation? The Minimum Payment Ploy has fuelled unprecedented growth in consumer spending, which could only have been achieved with borrowed money because it has outpaced the growth in our incomes. All that credit gives us the ability to live well beyond our means, creating the illusion that we are rich … until the payments come due.

  Are you a sucker? If you make only the minimum monthly payment on your credit card balance, you are. Let’s say you’re using a credit card that charges 17.99% interest on purchases for which the minimum payment is the interest + $10 + fees, or 2.25%, whichever is less. Now, let’s say you’re carrying a balance of $3,600 and are making the minimum payment, which would be about $64 (the interest + $10). Since you’re only paying $10 a month off the amount you owe, it’s going to take a long, long time to get this card paid off. How long exactly? Well, 106 months, or 8.8 years! And do you have any idea how much interest you’ll end up paying on that $3,600 balance? $3,384. Yup, you’ll pay almost as much in interest as you originally charged. Those shoes you bought at 40% off don’t look like such a good deal right now, do they?

  Want to be debt-free? You need to figure out how much you must pay to not only meet your minimums, but to get yourself out of hock. Time for more math.

  WHAT’S IT GOING TO COST TO GET OUT OF DEBT?

  Go back to your Debt List and figure out what you’ll have to spend every month to dig yourself out of the hole. You’ve already calculated what the monthly interest cost is on each of your consumer debts. Now it’s time to look at how to get the principal paid off. Your list may look like this:

  Let’s take the department store credit card as our first example. (For the purpose of this example, we’re going to assume the interest rate has remained the same because, try as you might, with your crappy credit history no one would cut you any slack.) The amount owed is $700. Your objective is to have that balance paid off in 36 months or less and avoid Debt Fatigue.

  GAIL’S TIPS

  Debt Fatigue is what happens to you when you’ve been in a hole so long you can’t even imagine daylight anymore. You’ve lost hope. You’ve started spending again after being overwhelmed by the amount of debt you have and the seeming futility of your debt repayment process. You’ve given up and gone shopping.

  Debt Fatigue is a big contributor to most people staying in debt. The sense of never being able to change things overwhelms even the best of intentions. To avoid Debt Fatigue, you have to be able to see the light at the end of the tunnel.

  It doesn’t matter how long you’ve been in debt, or how big your debt is, if you want that life to be better than it has been, if you want it to be free of debt, then this is where you draw the line in the sand. You must make a plan to be consumer debt-free in 36 months or less.

  How long you’re prepared to live in misery is up to you. You can bite the bullet and do what it takes to reclaim your life or you can keep mewling about how hard it is to get to even. But while you’re whimpering, you’re paying a ton of interest too, money that could be better used doing something nice for someone you love: you.

  To have that credit card paid off in 36 months or less would cost you $19.44 ($700 4 ÷ 36 = $19.44). Now you have to add in the monthly interest cost, which we calculated at $16.80, for a total payment amount of $36.24. It’ll take about 36 payments of $36.24 to get that department store credit card paid off.

  CALCULATE YOUR NEW REPAYMENT AMOUNTS

  Take the same steps for every other debt on your list:

  1. Divide the amount owed by 36.

  2. Add the answer to the amount of interest you must pay each month. (Remember, to calculate the monthly interest cost, you multiply the amount you owe by the interest rate and divide it by 12.)

  3. The total is the amount you must pay to be rid of that debt in 36 months or less.

  Now your list looks like this:

  GAIL’S TIPS

  Since the interest is being calculated on a declining balance, each time you make a payment, the amount of interest the following month goes down, assuming you haven’t charged anything more or that your interest rate hasn’t gone up. That’s more complicated math than most people can handle, so we’ll use a steady interest rate for our calculations. If you want a dead-on amount for your budget, you can find an online calculator that can do the math for you. For now, work through this so that you understand what’s going on.

  Add up your Monthly Payments. That’s a crapload of money, isn’t it? But that’s what you’re going to have to come up with if you want to be consumer debt-free in three years or less. It may take you a minute or seven to wrap your head around your new debt repayment number.

  If you were not yet convinced of how important it is to get your interest rates down as low as possible, looking at a big, fat repayment amount may be just the motivation you need to get busy reducing your interest costs. If you have tried your best and couldn’t get your lenders to move, couldn’t consolidate, or couldn’t do a balance transfer, you’ll just have to suck it up and work with what you have. Six months of steady payments against your debt should go a long way to shining up your credit score, at which point you can call and negotiate, do a balance transfer, or get a consolidation loan to reduce your costs.

  If you’ve already got your rates down as low as they will go, you’ll have to find a way to make the plan work. That may mean cutting back even further on your expenses or getting another job or two to come up with the extra money you need for debt repayment. If you’re serious about being debt-free, you’ll do whatever it takes!

  SNOWBALLING YOUR PAYMENTS

  And now we come to the best strategy for taking those payments and making them really work for you if you haven’t consolidated or refinanced your home. You know how much you must put toward debt repayment to get out of the hole. But how you apply those payments makes all the difference in the world. The strategy is called Snowballing, and it involves putting your money where it’ll do the most good. Here’s how it works:

  1.Having figured out how much your monthly debt repayment amount must be—in our example, it’s a whopping $1,068.95—put that amount into your budget.

  2.You use as much as you need to make the minimum payments on all but your most expensive debt. In our example, it would take $846 a month to make the minimum payments on all the debt. It is very important that you keep up with all your minimum payments to protect your credit history from becoming bruised. Even one late payment could reduce your credit score and result in higher interest rates. So make sure you make all your minimum payments on time every month.

  3.Take all the rest ($1,068.95 – $846.00 = $222.95) and apply it against the debt with the highest interest rate. In the case of our $700 department store card, the payment of $250.95 (the minimum payment of $28 + the $222.95 we are snowballing) means it will take less than three months to get the balance paid off.

  4. Once the balance on your most expensive debt is paid off, start all over, applying the amount above the minimum payments to the next most expensive debt. The total debt repayment amount does not decrease until all the debt is gone, so don’t pat yourself on the back and go shopping. You’ve still got a long way to go.

  GAIL’S TIPS

  I know some people like to start with their smallest debt because they find it very “motivational” to get their small debts paid off. It’s that instant gratification thing that got most people into debt in the first place. Hunkering down to become debt-free forever isn’t just about “feeling good,” it’s about becoming debt-free as fast as possible. Paying off your most expensive debt first is the most efficient way to become debt-free. And when you’re debt-free, you’ll feel great!

  Now you’re going to snowball the amount you were paying on the first debt you’ve just vanquishe
d and put it into the payment against the next debt dragon you must face. On our sample list it’s the $1,200 owed on the department store credit card. Add the amount for the minimum payment for that debt ($48) to the amount you were using to repay the previous debt ($250.95), and you’ll have the amount ($48.00 + $250.95 = $298.95) that you’ll be using to pay off the $1,200 department store credit card balance. It’ll take about four months to slay the second debt dragon ($1,200.00 ÷ $298.95 = 4.0 months). As each debt is paid off, you continue to snowball the amount from the debt just paid off by adding it to the minimum payment on the next most expensive debt on your list.

  Do I actually have to say that you should not be using your credit for anything at all at this point. NOTHING! There is no good reason to spend on credit if you’re trying to get to debt-free. If you’re still using your credit, you’re not really serious about this. If you are serious, you’ve chopped up your cards so you can’t use them, and you’re living within your means.

  DON’T PROCRASTINATE!

  If you have to wait until your next pay period to get started, or until you know you have some extra money, or until [insert your pathetic excuse here], you’re procrastinating. How’s that working for ya? Any closer to being debt-free?

  If you want to be debt-free you must start TODAY. “But I don’t have the money,” you say. Well, then, either you’ll have to find a way to make more money or use the money you do have in a smarter way. Go over your budget with a paring knife and trim out all the non-essentials that are sucking away your money.

  Right now. I mean it. Grab your budget and start trimming your expenses.

  How much did you come up with?

  Do it again.

  Now how much do you have?

  Do it again.

  And again.

  You want your budget to be so tight it squeaks.

  GAIL’S TIPS

  Swap a bad habit for a good one. Love candy? Can’t walk by the coffee shop without dropping $3 for a caffeine boost? Smoke, drink pop or booze, chew gum? Start giving up your bad habit slowly, and reward yourself with a good one—debt repayment—as you do. Go from smoking 20 cigs a day to 15, and add the money you didn’t send up in smoke to your debt repayment plan. Walk past the coffee shop just once and you can add another $3 to your debt repayment. You’ll be amazed at how satisfying—and addictive—becoming debt-free can be. Once you’ve converted, find an apostle and spread the word!

  Add whatever you’ve squeezed out of your budget to the payment on your most expensive debt. If you managed to chop $300 from your expenses, add that $300 to the payment on the first debt on your list.

  GAIL’S TIPS

  Make a payment whenever you have an extra 10 bucks to dump on your debt. Don’t wait for the due date. If you owe money, it’s always due. The faster you make a payment, the quicker you turn off the interest clock.

  Every penny counts. Start carrying a notebook around with you, and whenever you save money on something—because you used a coupon, because you got it on sale, because you decided not to buy whatever it was that was on your list—write it in your notebook. When you get home at night, make a payment of however much you’ve saved that day against the debt that’s at the top of your list. (This assumes you don’t end up getting dinged for bank charges on every payment. If you have a transaction limit, save it all up and do it once at the end of the month.) Now you’ve put what you saved to good use, as opposed to leaving it in your cash flow where you just end up spending it on some other crap. Scour your house for all your change. And every time you empty your pockets of change, add it to your change pot. At the end of every week or month, deposit it to your bank account and then immediately use that money to make a payment against your most expensive debt.

  Have you heard? Less is the new more! If you have to sell stuff to get out of debt, that’s what you have to do. Go through your home, room by room, and choose two things you can live without. Have a yard sale, list things on craigslist or eBay, or sell things through a consignment shop. You might not get a lot for whatever you’re selling, but whatever you get is money you won’t have to pay interest on. Apply that money to the debt at the top of your list.

  GAIL’S TIPS

  As tempted as you may be to cash in some or all of your retirement assets to get rid of your debt, don’t do it. Not all sources of cash are appropriate for debt repayment. It’s never a good idea to cash in retirement assets to pay off debt because when you take money out of a retirement plan you trigger taxes on that money.

  The discomfort you’re experiencing from being in debt is good if it keeps you focused on getting back into the black. But if you can’t stand the weight of the debt, you want to get rid of your debt faster; instead of using 36 months as your end date, choose a shorter term. Thirty-six months is the longest it should take. But becoming debt-free forever may be so important to you that you choose to set a goal of being out of the hole in 30, 24, or even 12 months. While some people can plod their way to debt-free forever, maintaining a balanced life while they do so—and this is my preferred approach to everything—there are some folks for whom a single-minded focus is a key part of their success in getting to debt-free. These are the people who tend to dive into everything they do with fervour. If you are one of these people, setting a shorter timeline and busting your butt to get to debt-free may be the only way you can do it. So be it. Do whatever it takes.

  If you look at the work you’ve done and think it’s all too hard, there’s no point, it’s a lost cause, and you’ll never be debt-free, then you’re choosing not to take the steps necessary to get yourself out of debt. You can’t whine about being in debt. Nope. You’ve made your bed and now that it’s full of fleas, you’ve only the dog in the mirror to blame!

  Cancelling Credit Cards

  You’ve decided to become debt-free. You’ve taken the bull by the horns and not only made a budget, but come up with a debt repayment plan that will see you in the black in three years or less. While you still have a bunch of cards in your wallet, you’re determined to trim your exposure to credit. Here’s what you should do:

  Look back over your credit card statements to see which ones are the oldest and have the healthiest credit histories—read “no missed or late payments.” You’re going to hang on to these to keep your history intact until you’ve built a sparkling credit history elsewhere.

  Choose the two (at the most) cards that you want to keep. These cards may have lots of benefits: travel bonuses, cash back, really low interest rates, whatever toots your horn.

  If the card(s) you want to eliminate has a good history, start by reducing the limit on the card to reduce your credit exposure, but keep the card active. After six months, you should have built up a more solid history on your two newer cards, and can close the old card(s).

  GAIL’S TIPS

  Cutting up your cards does not cancel your account. It simply removes the ability to use the card—and the temptation to spend money you don’t have. If you want to cancel your credit cards, you should be aware of three things:

  1. The balance must be zero.

  2. Cancelling a card will mean you lose the credit history associated with that card.

  3. Cancelling a card does not always stop pre-authorized transactions from being approved on that card. So while you may have thought that closing the account would put an end to anything going through on that card, you would be wrong. If you want an account to actually be cancelled, you must report that card lost to ensure no further charges go through and, once you receive your new card, call and close the account.

  When you are reducing your credit limits, do not reduce your limit to the point where your balance is greater than 60% of your limit. Part of the credit scoring system looks at how much of your limit you’ve used up. The more often you bump your head against your limit, the lower your score. That’s why paying off $50 and then immediately lowering your limit by $50 can do more harm than good.

  When it comes to canc
elling a card, first make sure you’ve redeemed all your rewards (cuz they are hi-sto-ry) and also make sure there is a zero balance on the account. If the sales rep promises you her first-born to keep the card, stand your ground. Remember, you’ve already chosen the card (or two cards, at most) that you’re going to keep.

  Send written confirmation of your request to cancel to the card issuer and keep a copy on file. Fax it if you can so you have a record of its receipt. Ask for written confirmation of the account being closed.

  Once you receive confirmation that the card has been cancelled, wait six to eight weeks and then check your credit report. Remember, it’s your responsibility to verify that your credit report is accurate.

  GAIL’S TIPS

  You’re entitled to review your own credit history for free once a year. Contact:

  • Equifax Canada

  www.equifax.ca

  Tel.: 1–800–465–7166 or Fax: (514) 355–8502

  • TransUnion Canada

  www.transunion.ca

  Tel.: (905) 525–0262 or Toll-free: 1–800–663–9980 (except in Quebec)

  Tel.: (514) 335–0374 or Toll-free: 1–877–713–3393 (Quebec residents)

  If you decide to order your report through these companies’ websites, don’t use a public computer and always double-check the URL to make sure you don’t fall for an impostor site—there are lots of them. If you’re receiving a credit report by mail, have it sent to a secure address where curious eyes and sticky fingers can’t get at it.